Central banks still hold all the cards

Chairman of the US Federal Reserve Ben Bernanke listens during an open meeting of the Board of Governors of the Federal Reserve System in Washington.

If the opening salvos of 2013 tell investors anything, it's to keep their eyes fixed on the world's central banks rather than its more volatile politicians or even spluttering economies.

Given the US Federal Reserve's latest musings on Thursday about how long it can safely sustain its current super-easy monetary policy, that's not as unambiguously positive as it proved over the past 18 months.

Just a look at the jump in 10-year Treasury borrowing rates to 8-month highs early on Friday gives a glimpse into what might happen if dissenting views within the Fed spread when jobless rates ease closer to its now stated target of 6.5 percent.

An unchanged US unemployment rate of 7.8 percent in December may suggest that's a story for another time, but the episode does underline that central bank policy more than any other factor will continue to dominate global markets' direction for the foreseeable future.

If you'd ignored pretty much everything else last year and bet solely on the determination of the 'Big 4' central banks - the Fed, European Central Bank, Bank of Japan and Bank of England - to doggedly pursue market stability and economic reflation, then you'd have done handsomely.

Put another way, it was simply the hoary old adage of “Don't fight the Fed” - or more accurately, and perhaps more ominously: 'Don't fight the Fed, ECB, BoJ and BoE'.

“The Fed, the ECB and the BOJ are more aggressive with their QE (quantitative easing) operations than at any time in history,” said Stephen Jen, head of eponymous hedge fund SLJ Macro and long-standing sceptic on the efficacy of central bank money printing.

“Even I am turning more optimistic, but still cautiously so,” he told clients earlier this week. “The path of least resistance for risk assets remains up for now.”

SOMETHING FOR EVERYONE

You didn't have to be terribly discriminating last year in what assets you chose or even have a firm conviction on the long-term success of the extraordinary central bank activity.

The broadest measures of both developed and emerging stock markets as well as both investment-grade and 'junk' bonds all returned 10-20 percent last year. And even the so-called safe havens of US and German government bonds and gold got swept up in the slipstream - returning at least 5-10 percent too.

Only if you were still stuck in cash - where real losses in US dollar bills over the last three years have been bigger than even the 1970s - would you have continued to bleed money.

Within the hedge fund universe, those funds looking at basic value and growth strategies or emerging market plays significantly outperformed the typically more tactical and nimble macro funds or the often model-based trend followers.

Yet this “something for everyone” asset market upshot is the clearest illustration of the overpowering influence of central bank intervention and one that unnerves many sceptics - if only on the crude but sensible assumption that central banks won't intervene forever.

And ironically, it's the emergence of the long-desired recovery and reflation that may cause the biggest ructions.

By hastening the end of QE-related bond buying, a pick up in growth and job creation could at once boost government borrowing rates and debt servicing bills, tighten mortgage credit and narrow the perceived undervaluation of equity, drawing even the wariest funds back to stocks.

Even though the New Year's Eve budget compromise between Washington's warring factions was widely panned by economists as an unsatisfactory short-term fix, global stock markets greeted the swerve from the 'fiscal cliff' with the biggest one-day rally in six months.

The calculation, not unlike the past two years of euro sovereign debt crises, has been that if the politicians can at least avoid a near-term disaster, then the central banks will keep everything afloat until a resolution emerges eventually.

For good or ill, the revelation of the internal Fed debate on Thursday therefore packs a punch.

Yet many traders reckon this is still not a dominant story until 2014. What's more, while the ECB may also be a third of the way through its three-year cheap loan spree to its banks, the bloc is also still in recession and there's at least two years to that payback. The Bank of Japan is even preparing to ramp up its yen-weakening QE after election pledges made by the incoming government of Shinzo Abe.

So, don't fight the central banks - either way they go - but the status quo may prevail for while longer yet.

“Global markets are temporarily over-panicking about the Fed's FOMC minutes and the suggestion that at some point, some normalisation of Fed's monetary policy will be necessary. Sorry, but I knew that,” said Societe Generale's emerging markets strategist Benoit Anne.

“Is the Fed going to maintain an accommodative bias in the period ahead? For sure, yes. From this standpoint, I am going to start being nervous when it is time to consider a major retrenchment of global liquidity. This is way too soon to worry about that.” - Reuters